My college refunded tuition paid with 529 Plan funds. What do I do?
This spring, the coronavirus health crisis swept across the country, forcing businesses and institutions alike to make drastic changes — colleges included. With in-person classes cancelled and dorms closed, some schools are now sending refunds for unused expenses. Sounds like a well-timed cash bonus, right? Well, if you paid for certain college costs from your 529 Plan, the refund you received may mean a tax bill, not a windfall.
Does this scenario seem familiar to your household? You may be wondering what you should do to get back on track with 529 Plan withdrawal rules. Look no further; the team at H&R Block has you covered. We’ll walk you through what you need to know, so you can avoid any 529 Plan tax surprises.
529 withdrawal rules and special coronavirus considerations
To start, let’s recap what qualified distributions are and how they normally work. When you take funds out of your 529 Plan, you won’t need to pay federal or state taxes on the distribution as long as you use the withdrawal for qualified education expenses. Costs for tuition, fees, room and board paid to an accredited institution are examples of expenses that count in the qualified category.
In most cases, if your college issues a refund for a qualified expense, you have 60 days to reinvest the money back into your 529 account. Right now, you might be counting the days since your college issued the refund to see if your 60-day window has passed. Luckily, recent IRS guidance gives you some additional time to recontribute the refunded amount back to your account.
With the IRS announcement, you have the following options:
- Redeposit the refunded amount by July 15, 2020, or 60-days after the refund was issued, whichever date is later.
- Apply the funds to other qualified expenses later this year. Be sure to spend it on expenses for the fall semester as the funds need to be used by December 31, 2020.
Of course, if this was your last semester or you don’t plan to return to classes, the second option won’t apply to your situation. If that’s the case, you may be able to rollover the distribution tax-free to a 529 plan for another family member, such as a sister or brother of the graduate.
What else should you know about 529 recontributions?
- 529 recontributions aren’t considered new contributions. In other words, they won’t be counted towards your plan’s contribution maximum.
- You may be hit with tax consequences if you don’t recontribute the refunded amount, or use the funds later this year, or rollover the funds to another plan. Because your expenses are now non-qualified, you’re subject to taxes and a 10% penalty on the earnings portion of your distribution.
How should you complete the 529 recontribution?
- Talk to your 529 Plan administrator to see what they need to complete the recontribution. Some state plans have special forms to use. You shouldn’t need to provide any proof that your university closed due to the coronavirus pandemic.
- Send a check with a letter of instruction to your plan administrator versus contributing on the plan’s website. This way you have a paper trail in case you need it for the IRS. Be sure to make a copy for yourself and include the following:
- The name of the school, as well as the date, and the amount that was refunded.
- An acknowledgement that you’re making a 529 recontribution following the IRS’s guidance (Notice 2020-23).
- You can also write “529 recontribution of 2020 refund” on the check memo line.
What should you expect to report for your 529 Plan next tax season?
Your 529 Plan administrator will send you Form 1099-Q around January of next year. This form will report your original distribution from the plan and break out how much of your distribution was your basis and earnings. You’ll use this information to figure out any taxable amount.
But wait – haven’t we been talking about how you can avoid unnecessary 529 Plan taxes? Yes, it’s possible to do so. If your entire distributed amount was either spent on qualified expenses or recontributed, you should generally end up with no taxes due.
As you’re looking for other tax documents to arrive next year, don’t wait around for any forms to show that you recontributed your refund — there aren’t any. That’s why keeping a record of your instructions is a smart bet. Just be sure to store it alongside your 2020 tax documents.
Help with 529 Plan taxes
529 withdrawal rules can get a bit complicated in a normal tax year. Throw in the fast-moving changes of these extraordinary times and it becomes even more daunting. If you need help, we’re here for you. Find out how you can work with one of our tax pros to get your questions answered.
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